Utter madness

Pakistan’s economic management, particularly its treatment of export-oriented industries, is nothing short of complete madness.

At a time when Pakistan is facing its worst-ever economic crisis—with a foreign exchange shortfall exceeding $25 billion per annum over the next five years, extreme uncertainty surrounding the IMF programme, and struggling to secure rollovers and additional financing amidst a junk credit rating—the government is stifling sectors capable of delivering upwards of $15 billion in additional export revenue if the policy mess is addressed.

Whether it’s IT, textiles, leather, or other key industries, every sector is being squeezed under the weight of misguided policies, eroding their capacity to contribute to economic recovery.

Presumptive tax measures to increase revenue collection have instead crippled businesses that are otherwise drivers of economic stability and growth towards collapse.

The textile and apparel industry, a once thriving sector responding for over 60% of export revenue, finds itself suffocated under the weight of an incoherent tax regime, delayed refunds, skyrocketing energy prices, and a failure by the government to respond to its repeated calls for action.

As economic activity collapses, tax revenue inevitably declines; expecting higher collection from a dwindling economy is completely irrational. This is not just a story of mismanagement but a case study in how flawed government policies can bring even the most resilient industries to their knees.

Perhaps one of the most mind-boggling decisions in recent months was the withdrawal of zero-rating on local supplies under the Export Facilitation Scheme. This single policy move has nearly wiped-out Pakistan’s spinning and weaving sectors that were already struggling to compete due to prohibitive energy prices.

By imposing sales tax on domestically manufactured inputs, the government has effectively afforded protection to imports of yarn and cloth.

Why would exporters buy local inputs and then wait months, or perhaps indefinitely, for refunds? As expected, they’ve shifted to imports, leaving the local upstream industry high and dry with no market for their goods.

Pakistan was once home to a full textile and apparel value chain, a rare asset in the global market. Apart from India and China, no other country has this capability. But it’s better to speak of this in the past tense because these sectors are now on life support thanks to blundersome government policies.

As international markets move towards “super-vendors”—large, vertically integrated and horizontally diversified companies or groups of companies that can provide end-to-end solutions—Pakistan’s textile industry is being left behind.

Super-vendors are becoming the future of global value chains. These are firms that can handle everything from design and raw material sourcing to production, logistics, and even marketing. In a world where geopolitical and climate risks are disrupting global supply chains, retailers and buying houses want fewer, more reliable partners. Pakistan should have been at the forefront of this shift, but instead, it is missing yet another train, thanks to an inept policy apparatus.

Another major factor contributing to the economic turmoil is the dysfunction of Pakistan’s tax system, especially with respect to the Federal Board of Revenue (FBR). The current tax regime has become an elaborate exercise in futility—ineffectual for businesses and a disaster for government revenue collection.

Since the implementation of SRO 350, every month, businesses across Pakistan brace themselves for the chaotic routine of filing sales tax returns. Like clockwork, government and public-sector entities fail to file their own returns on time, resulting in cascading delays for everyone else.

This causes a ripple effect where businesses are unable to file their returns, and in-turn their customers and then their customers are unable to file their returns, leading to undue penalties for all.

Repeated pleas from the private sector, as well as explicit directives from the Prime Minister himself, have been met with indifference by the FBR. It’s as if the state has abandoned any pretence of collaboration with sectors that drive the economy.

After businesses spend precious time and resources meticulously filing their returns, the expectation would be that sales tax refunds, particularly under the FASTER scheme, are processed in a timely manner.

The law is clear on this: Rule 39F of the Sales Tax Rules 2006 mandates that refunds under the FASTER system should be processed within 72 hours. Yet, the FBR now routinely delays these payments, holding hostage the liquidity that exporters desperately need.

For the government, this is a cash-flow management tactic. For businesses, it’s a chokehold, stifling their ability to function. The opportunity cost is staggering—if these funds were simply parked in banks, the return would be 20%. But as working capital or for reinvestment in production, that figure would be much higher.

What kind of economic strategy is this? The government squeezes the lifeblood out of exporters to pay for bureaucratic inefficiencies. It’s a cruel irony that businesses, trying to contribute to national growth, are being taxed to pay for the very apparatus that’s dragging them down.

How does the FBR justify sacrificing industry liquidity to fund its sprawling, inefficient structure—epitomized by the 172 malis mowing its lawns?

Pakistan’s textile and apparel sector is a high-volume, low-margin business. Between an 18% tax on all inputs, a 1.25% minimum turnover tax, and a 1.25% tax on export proceeds (including the EDF surcharge), the cumulative burden on businesses is unsustainable.

When the government effectively drains 20% of a company’s revenue through various taxes while simultaneously blocking access to refunds, how can any business survive? It’s a marvel that any manufacturers are still surviving.

And the worst is yet to come. As pointed out by a notable economist in his recent op-ed, the FBR’s tax collection numbers for FY2024 are, predictably, fudged. As a result, there are already considerations of additional withholding taxes being imposed starting October.

Worse, there are strong indications that sales tax refunds to exporters are going to be severely curtailed, if not entirely frozen. Despite being repeatedly warned that this punitive tax regime will not work—especially with rampant inflation and soaring energy prices—the government has ignored all advice.

It’s not that there isn’t demand in international markets. With the West decoupling from China and Bangladesh grappling with its own crises, Pakistan has a golden opportunity to expand its export base. Yet, businesses lack the working capital to take advantage of these opportunities. The export orders are there, but the liquidity and business environment aren’t.

And perhaps the biggest nail in the coffin is energy. The government talks a big game about resolving the power sector’s woes, but for the private sector, the situation has gone from bad to worse.

Power tariffs exceed 15 cents/kWh, rendering grid electricity financially unviable for most industrial players, given their competitors in India, Bangladesh and Vietnam get the same for 6-9 cents/kWh. What’s left of the sector has only managed to survive on gas-fired captive power plants. Now, the government is gunning for those too.

Captive power plants are an integral part of industrial processes worldwide. The government’s attempt to phase out captive generation is not only misguided but also destructive.

Co-generation is far more efficient than grid power, and advanced economies like the US and EU actively promote it as a greener, more sustainable alternative. Emerging markets like Indonesia are doing the same. Yet here we are, in Pakistan, bent on shutting down the very systems that the world is promoting, and which help keep industry alive.

Activities taking place within the walls of a factory are part of the manufacturing process. Forcing businesses to abandon captive power in favour of a dying grid makes no economic sense.

At current grid prices, businesses will either transition to other alternatives—such as biogas, coal, or furnace oil—or they will shut down, as many have already done. Captive power, particularly combined heat and power, doesn’t just generate electricity; it also produces heat, which is vital for many industrial processes.

It is imperative that captive be classified under the industrial gas tariff category, as the gas used in these systems is integral to the industrial process itself, not merely for power generation. Penalizing captive users by making them pay punitive tariffs for gas, rife with cross-subsidies and the gas companies’ losses, is nothing short of self-sabotage.

The picture couldn’t be clearer: the government is at war with its own economy. Instead of fostering an environment where businesses can thrive, it is systematically draining them of their resources, cutting them off from markets, and punishing them for trying to compete globally. The tax regime is broken, the energy policy is a disaster, and despite countless warnings, there seems to be no end to the madness.

Yet, the choice is still there, but ever fleeting. On one path lies an opportunity to capitalize on global market trends, attract international buyers, and solidify Pakistan’s position as a key player in the global textile and apparel value chain.

On the other lies continued stagnation, driven by shortsighted policies that choke the very businesses they are supposed to support. If the government doesn’t get its act together soon, there won’t be much of an industry left to save.

Copyright Business Recorder, 2024